Bailouts, Reframed as 'Orderly Resolutions' - Commentary by Robert J. Shiller
"Bailouts, Reframed as 'Orderly Resolutions'"
By Robert J. Shiller
Published in the New York Times on November 14, 2010
Read the article in its original context on the New York Times website.
Distasteful as it may seem, we need to prepare for the next financial crisis, which, of course, will arrive eventually. Right now, though, people are so angry about the recent bailouts of Wall Street that the government may not be able to use the same playbook again.
The criticism has emphasized the trillions of taxpayer dollars that the bailouts put at risk. But, in fact, the realized losses were minuscule when compared with the widespread suffering they averted. The net losses of the $700 billion Troubled Asset Relief Program, for example, which ran from October 2008 to October 2010, amounted to only $30 billion by the latest estimate. Yet TARP may have prevented many trillions of dollars of losses in gross domestic product.
Our principal hope for dealing with the next big crisis is the Dodd-Frank Act, signed by President Obama in July. It calls for bailouts of a sort, but has reframed them so they may look better to taxpayers. Now they will be called "orderly resolutions."
Psychologists tell us that subtle changes in framing — in the names we call things, the context in which we observe them, and their superficial appearances — can bring major changes in perception. Title II of the Dodd-Frank Act, "Orderly Liquidation Authority," stipulates that the next time a Bear Stearns or a Lehman Brothers heads toward crisis, the Federal Deposit Insurance Corporation can act swiftly to create a "bridge financial company" that can keep doing much of the company’s business — thereby bailing out many people who count on it, excluding its stockholders, to prevent a house-of-cards collapse of the financial system.
"Bridge financial company" is a new term, but there is a precedent, called a “bridge bank,” that the F.D.I.C. has used for many years. In essence, Dodd-Frank is asking the F.D.I.C. to do much the same thing for a wide spectrum of financial companies as it has done with traditional banks.
On a Friday in July 2008, for example, the F.D.I.C. kept IndyMac Bank alive when its survival was in doubt. The agency moved in swiftly to transform IndyMac into a bridge bank, called the IndyMac Federal Bank, and the changeover went so smoothly that many depositors might not have even noticed. The cash machines remained in operation over the weekend, and, on Monday, customers saw what seemed to be the same bank.
Later, OneWest Bank took over IndyMac accounts and mortgages — but only after the F.D.I.C. promised to share the losses on the bad mortgages being acquired, according to a complicated agreement.
When life is smooth, people tend to remain complacent, reflecting confidence in the economy. In times of crisis, such confidence is also vital, even if government can’t absolutely guarantee that it’s justified. In the future, extending such bridge operations to the likes of a Bear Stearns or a Lehman would hold risks as well as benefits for taxpayer money. That’s where the reframing comes in.
The Dodd-Frank Act acknowledges that when the F.D.I.C. moves into deals like this with financial companies, it may need some assistance. So the law creates an Orderly Liquidation Fund at the Treasury, which can issue debt for it as needed. Of course, that could be interpreted as a bailout that uses taxpayers’ money, since the debt has to be repaid somehow.
But here’s the reframing: The Dodd-Frank Act specifies that the F.D.I.C. will be paid back through "assessments" on financial companies. These assessments won’t be paid immediately — because such burdens on weakened financial institutions during a financial crisis would put the whole economy at risk. The Treasury can intervene first and be repaid later.
This is a classic and potentially effective reframing. Why? The payments are called "assessments," not taxes. And the context has changed, with the burden appearing to fall squarely on Wall Street, and not on taxpayers.
Of course, reframing won’t convince everyone that the government’s interventions are benign. In fact, an assessment is much the same thing as a tax — but placed on businesses rather than on individuals. Ultimately, however, this tax is really paid by the public, because those financial companies are owned by thousands upon thousands of individuals, even though many may not know it. Many people of middle income hold their shares in pension plans or mutual fund accounts, or in the endowments of the churches or colleges to which they contribute.
The government has been carefully framing its actions for years. The corporate profits tax, for example, is framed as a tax on "them" rather than "us," but, in fact, the public owns corporations. And a good part of that tax is passed on to consumers in the form of higher prices. (The same, of course, would happen with the Dodd-Frank assessments.)
In another example, Keynesian economic stimulus through government deficit spending might be ineffective if it were subjected to rational analysis by consumers, as Robert Barro of Harvard has eloquently argued. People might hesitate to spend their tax rebates today, for instance, if it were clear that future tax increases would be needed to offset the resulting national debt.
The general taxpaying public may never figure out the true effect of the corporate profits tax, or the present value of tax bills far in the future. But many people have acquired a sense of suspicion that anything that looks remotely like government largess will show up in higher taxes someday. That is part of the reason for the rise of the Tea Party movement, and was a factor in the recent midterm elections.
Still, well-thought-out framing packages can work. They can help sell crucial intervention packages to people who don’t fully understand the financial system’s complexities or how government interventions prevent disasters.
Unemployment is near 10 percent, though it certainly would be much higher had the government not embarked on bailouts. We have to hope that the Dodd-Frank reframing succeeds — and that taxpayer anger doesn’t scare the government away from following the law’s intent aggressively. Such timidity could allow more Lehman-type failures.
The framing of the Orderly Liquidation Authority might be regarded as a form of diplomacy, needed to avoid unwanted anxieties that could prevent the Treasury and the F.D.I.C. from taking strong action to support our financial system.
This is vitally important. We avoided a depression in 2008 and 2009, and we need to do so again when the next crisis arrives.
Robert J. Shiller is professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC.